The federal government doesn't just magically print money and use it to fund Social Security. Rather, the program is financed primarily through payroll tax revenue.
When you collect your paycheck and notice a line item for FICA, that's the money you're paying into Social Security. And while you may not enjoy doing that, you probably will enjoy getting to collect a monthly benefit once you retire.
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But payroll taxes aren't the only revenue stream for Social Security. The program also gets money by taxing benefits.
President Trump has stated that he'd like to put an end to taxes on Social Security. But that could cause the program to lose out on critical revenue. So a better approach may be to simply update the rules that determine when those benefits are taxed.
The current system is flawed
A lot of people think it's unfair that seniors have to pay taxes on their Social Security. In fact, some might call it a form of double taxation, since workers are first paying taxes on their wages and are then being taxed on the retirement benefits they're supposed to get in return.
But the fact of the matter is that Social Security needs revenue. So getting rid of taxes on benefits may not be the most prudent thing to do. A more reasonable solution, however, could be to update the income thresholds at which taxes on those benefits apply.
The problem is that the aforementioned thresholds were established decades ago and have not been adjusted for inflation -- even though Social Security benefits themselves have had almost yearly boosts over the past few decades thanks to automatic cost-of-living adjustments, or COLAs.
Right now, seniors pay taxes on Social Security benefits once their combined income exceeds $25,000 in the case of individuals, or $32,000 in the case of joint filers. Combined income is calculated based on adjusted gross income, tax-exempt interest income you collect, and 50% of annual Social Security income.
But as you can see, these thresholds are very low.
The average Social Security recipient today collects about $1,979 a month, or $23,748 per year. When we cut that in half, it amounts to $11,874 in Social Security. An individual who withdraws more than $13,126 from their retirement savings annually would be subject to taxes on their Social Security if they receive the average monthly benefit.
Put another way, it's feasible that someone collecting about $24,000 a year in Social Security plus another $13,000 from savings for a total of about $37,000 in actual income would face taxes on their monthly benefits. That hardly seems right.
A change needs to be made
It may not be reasonable to eliminate taxes on Social Security benefits altogether. But it's also not so reasonable to impose taxes on benefits for retirees with modest or minimal incomes.
If Social Security benefits are eligible for annual COLAs, then the combined income thresholds should be adjusted for inflation, too. That's really the only fair way to go about things.
Of course, lawmakers have their hands full on the Social Security front trying to prevent benefit cuts. So they may not be too eager to mess with the combined income thresholds anytime soon. But it's very much an outdated rule that sorely needs an update.
